Avoid Priceline Till European Recovery In Sight

Priceline (NASDAQ:PCLN), a leading online travel agency, reported its 2Q2012 results yesterday, in which the company's EPS beat the Street's estimates by 6%, based on gross bookings. Revenue missed analyst estimates, but was up 21% compared with the same quarter last year. While things do not look that bad compared with last quarter's results, the company gave a weaker 3Q outlook than what analysts had expected. PCLN derives 60% of its room bookings revenue from Europe through bookings.com, and is affected by the European crisis, which has shown no signs of ending within this year. This European impact is enhanced by the euro performing poorly against the dollar. PCLN's shares were down 14% in after-market trading. We update our earlier investment thesis, and advise investors to buy PCLN once the European economy starts to recover.

Earnings Analysis and Future Outlook

The table below gives the summary of 2Q results, as well as the guidance for the third quarter of this year. There was an earnings surprise of 6.6%. Revenue was within the guidance range of 18%-23% issued with 1Q results, although it missed analyst estimates.

2Q2012 result

Actual

Estimates

Change over last year

Revenue

$1.33B

$1.35B

21%

EPS

$7.85

$7.37

43%

Guidance

Guidance

Estimates

Change over last year

3Q2012 EPS outlook

$11.1-$12.1

$12.8

12%-22%

3Q2012 Sales

$1.6B-$1.7B

$1.8B

9%-15%

Click to enlarge

Priceline has a high beta of 1.95 [compared with Expedia's (NASDAQ:EXPE) 1], according to Yahoo Finance, and is therefore adversely affected by the weakening economy. The decline in year-over-year growth of EPS, compared with 1Q2012, means that the company is facing a tough time with regards to growing its bookings at the same pace as before. International gross bookings grew 44%, down from 58% in 1Q. 3Q bookings are expected to increase 10%-18%, compared with 27% in 2Q. The 3Q guidance is issued with the expectations of a further deterioration in the European situation.

For the month of June, the table below gives a rough idea of the bookings scenario faced by Priceline in Europe. The currency clearly has a large impact, in addition to slightly less occupancy. YTD occupancy rates are flat.

The European figures for July and August might benefit from the London Olympics. The total number of tourists visiting London is 1.5 million (294,000 from abroad). The number of hotel rooms in London is 110,000. The table (in pounds) below gives some idea of the impact of the Olympics.

During the first quarter reported on May 9, the company exceeded analyst EPS estimates, but missed revenue estimates. PCLN had warned about currency headwinds for 2Q at that time, despite an increase in car rentals and hotel bookings. The share price fell from $718 on May 9 to $681 on May 10. This dropped further to $632 on May 18, and then started recovering slowly (5%), up till the decline yesterday.

Competition

Things look better for Expedia, which is more exposed to the U.S. According to STR Global, occupancy rates in the U.S. increased 3.3% (YoY) to 75.1% for the week ended July 28. Average daily rate or ADR was up 4.8% to $108.95. Revenue per available room was $81.87 (showing an increase of 8.2%). Overall, July showed increases in all three metrics YoY. 40% of PCLN's revenue comes from its U.S. operations in 2011, while the figure is 58% for EXPE.

Expedia was also able to beat both its revenue and EPS estimates in its latest quarterly results. In our last article, we mentioned that Priceline had consistently been beating its competitors in revenue growth, despite the tough competition it faces. Given the European situation, this might not be true in the short run.

On the other hand, the company's plans to expand in Asia Pacific, as well as the Americas, contribute to its PEG ratio of 0.92, compared with Expedia's 1.64. The company has announced an agreement with China's Ctrip.com, giving the latter customer access to booking.com's hotel portfolio. This move will help strengthen the company's position in the faster growing Asia Pacific region, which is served by Priceline's Agoda.

Valuation

Some sell-side analysts cut their price targets for PCLN today. Among them were JPMorgan (NYSE:JPM), Deutsche Bank (NYSE:DB) and Barclays (BARC). JPMorgan reduced its target by $120 to $650. Barclays cut the target price to $725 from $800. Both aforementioned names maintained their overweight rating. Deutsche Bank cut its target price from $713 to $675, while maintaining its buy rating for PCLN.

The 15% decline in PCLN during after-hours trading was imitated by competitors like Expedia and Orbitz Worldwide (NYSE:OWW), which went down by 3.8% and 2.8%, respectively.

Although there might be a rebound from the sharp $100 decline in after-market trading, we advise against a long position in the short run. Over the longer term, we will advise a long position only when the domestic and European economies recover. At present, Expedia seems to be a better pick, with its U.S. operations helping it to exceed analyst estimates in its latest quarter.

However, the trend toward online transactions/business, coupled with the successful "name your own price business" model, can help Priceline deliver better results under better economic conditions.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.